Two Worlds Collide: The Financial/Political Elephant

"In politics, nothing happens by accident. If it happens, you can bet it was
planned that way." Franklin Delano Roosevelt

Anyone looking solely at the patterns of US and European stock indices in
the last three months since Ukraine became the center of escalating tensions
inside the nation and outside between Russia and Europe & the US, would
come to the conclusion none of this had anything to do with the lives of billions
depending on our global financial markets. When we consider the cracking of
the largest real east bubble in history in China, as they strengthen their
relationship with Russia and Europe simultaneously, it seems surreal to watch
western markets give off the impression that none of these events could impact
their stock "nirvana" state.

Yet, the juxtaposed worlds of calm US and European markets with escalating
tensions between Russia and the West - remember, first quarter growth (GDP)
in the
US and Europe was
slightly above zero in both of these major engines of the global economy -
have created a cognitive dissonance between these two views of the current
financial landscape and the idea of risk.

What are we to make of the "elephant" that entered our daily news in the last
3 months? Is it worthy of our attention, or a side issue in the larger global
picture?

This article is laid out according to John Godfrey Saxe's poem of an Indian
legend, The
Blind Men and the Elephant. I have left my own comments until the end,
since I believe the collection of news sources is even more powerful.

I hope that you will take time to investigate each of these themes, since
they reveal various aspects of "the elephant" we normally may never consider.
How much longer can global trading computers and individuals ignore its presence?

Sanctions on Russian exports would greatly expose the EU. Europe imports 30
percents of its gas from the Russian state-owned company Gazprom. Russia is
also Europe's biggest customer. The EU is, by far, Russia's leading trade partner
and accounts for about 50 percent of all Russian exports and imports. In 2014,
EU-Russia overall trade stands at around 360 billion Euros per year. The EU
is also the largest investor in the Russian economy and accounts for 75 percent
of all foreign investments in Russia.

Rosneft is the largest listed oil company in the world and, as such, has partners
worldwide, including in the West. For example, the US-based company Exxon-Mobil
has a $500 million oil-exploration project with Rosneft in Siberia, and Exxon-Mobil
is already in partnership with the Russian giant oil company to exploit Black
Sea oil reserves.

Russian president Vladimir Putin kept Joe Kaeser waiting for an hour before
their meeting this week at his residence outside Moscow.

That gave Siemens' chief executive a chance to ponder how he was going to
explain to a German TV audience that evening why he called on Mr Putin even
as the US and Europe were trying to further isolate Russia over its actions
in Crimea.

The German engineering company has pledged to invest €1 bn in Russia
and sells express trains, energy infrastructure and medical technology there.

Although Siemens' boss gave every impression of conducting business as usual,
German companies are deeply concerned about their business ties with Russia
and most oppose economic sanctions.

German entities have invested roughly €20bn in Russia and some 6,200
companies - mostly small and medium-sized Mittelstand businesses - are active
there. Last year trade between the two countries totaled more than €76bn.

These business links are a restraining hand on Berlin as it considers further
action against Russia; Berlin is well aware that restrictions that hurt the
Russian economy could also hurt Germany too.

A swath of companies, from banks to brewers, are taking big hits to their
bottom lines caused by the political uncertainty surrounding Moscow's standoff
with the West over Ukraine and the dwindling Russian economy.

Under Russia's new legislation, Visa and MasterCard will have to pay $3 billion
in 'security fees' to continue operating in Russia, more than five times higher
than the companies combined revenues, a new Morgan Stanley report says.

Under the new plan, Visa will be required to pay Russia's Central bank $1.9
billion, and MasterCard will have to fork out $1 billion, according to an estimate
by Morgan Stanley, Kommersant reported on Thursday.

Russian President Vladimir Putin signed a law on foreign payment systems on
May 5 that requires foreign payment systems to be levied at 25 percent of an
average amount of transfers profit during one calendar day in Russia, to be
paid each quarter to the Central Bank. The law will be enacted on July 1.

Morgan Stanley has calculated that it is unprofitable for both Visa and MasterCard
to continue to work in Russia.

Trunk - International Banking Centered Around
Ukraine

While bond markets have reacted jubilantly to the possibility of Western aid
for Ukraine, big-name investors are worried about how fast Kiev can secure
a rescue and whether an IMF bailout may reschedule its debts.

Credit ratings for European lenders could be slashed by one or two notches
as the move towards "bail-ins" away from government "bailouts" continues to
evolve, a leading credit agency [S&P] warned.

Following similar moves in the U.S., European banks could lose top investment
grade ratings if regulators continue to look at ways to avoid taxpayers having
to prop up struggling banks, as they did at the height of the global financial
crash of 2008.

While the sight of Russian flags, pro-Russian troops, and Russian navy ships
in Crimea is now a day-to-day thing; this morning brings a new normal for the
eastern Ukraine region - long lines at bank ATMs as the bank runs have begun.... it
is Deutsche Bank's comments this morning that raised many an eyebrow as they
suggest that Ukraine's debt is pricing in a "burden-sharing" haircut for
bondholders (which as we have seen in the past - in Cyprus - can quickly ripple
up the capital structure and become a depositor haircut).

The prices of European bank stocks and bonds tumbled, some banks operating
in Ukraine imposed limits on withdrawals from their cash machines, and one
bank put on hold the process of selling its Ukrainian unit.

Russian banks suffered the most, with London-listed shares of OAO Sberbank and
OAO VTB, the country's two largest lenders, fell more than 16% and 18% respectively.
Shares of UniCredit and Société Générale, which
owns one of Russia's largest retail and corporate banks, both fell about 5%.

According to a report in Kommersant-Ukraine, the finance ministry of Washington's
stooges in Kiev who are pretending to be a government has prepared an economic
austerity plan that will cut Ukrainian pensions from $160 to $80 so that Western
bankers who lent money to Ukraine can be repaid at the expense of Ukraine's
poor....

The corrupt Western media describes loans as "aid." However, the 11 billion
euros that the EU is offering Kiev is not aid. It is a
loan. Moreover, it comes with many strings, including Kiev's acceptance
of an IMF austerity plan.

The International Monetary Fund has approved a $17bn two-year loan programme
for Ukraine, as Kiev continues to fight pro-Moscow separatists in the east
of the country.

Wednesday's action by the IMF's 24-member executive board, which includes
representatives from Russia and the United States, opens the way for an immediate
release of $3.2bn to Ukraine, which faces deep fiscal problems in addition
to months of political crisis.

The loans are subject to IMF demands that Ukraine cuts subsidies for fuel,
reduces its large deficit, controls pay rises, reduces corruption, and reforms
its banking system.

Russia supported an International Monetary Fund package for Ukraine last week
but sees risks of Kiev failing to meet the criteria, Deputy Finance Minister
Sergei Storchak said on Tuesday.

The IMF signed off on a $17 billion bailout for Ukraine last week, with tough
conditions including steep gas tariff hikes, a floating exchange rate and reducing
the budget deficit by about 2 percent of GDP each year from 2014-2016.... He
(Storchak) added that "the success of the programme very strongly depends on
several risks which Ukraine, judging by everything, doesn't control yet".

Meanwhile, Ukraine has accused Russia of using gas as a political weapon,
as Russia demands prepayment of $1.66 billion for June gas deliveries.

Tusk - Financial Sanctions

President Obama signed an Executive Order Thursday allowing the U.S. government
to impose a host of sanctions on both individuals and entities deemed to be
violating Ukraine's sovereignty and territorial integrity.

In a phone call with reporters, senior administration officials discussed
the Executive Order and said it is intended to, "send a strong message that
we intend to impose costs on Russia for this intervention." And will give the
U.S. government "powerful and flexible tools" to target those who are believed
to be violating international law.

Western countries and Japan have suspended their 16-year collaboration with
Russia in the G8 group in response to the annexation of Crimea and have threatened
sweeping sanctions in the event of any Russian military moves in the region.

The move, a clear and deliberate break from the post-Soviet status quo, was
intended to underline Russian isolation....

The G7 leaders issued a joint statement, under the title of the Hague Declaration,
saying they would not attend a planned G8 summit in Sochi in June but would
instead convene without Russia in Brussels
(on June 4-5).[Italics mine]

Undeterred by a new round of Western sanctions on Russia over Ukraine early
this week, the world's leading energy firms are moving ahead with major oil
and gas projects in Russia. EU and US sanctions targeting individuals and ancillary
companies have given American and European firms little reason to change course
on ventures that could yield billions in new resource flows, largely in Russia's
coveted Arctic region.

Moscow, in turn, has little reason to react. With the continued backing of
BP, ExxonMobil, Royal Dutch Shell, and others, the Kremlin can feel better
about its economic outlook. It's why some in Washington and Brussels have called
for more aggressive measures that target entire energy companies, or even the
industry as a whole, which makes up about half of the Russian government's
revenues.

Germany and France are ready to agree more extensive sanctions against Russia
if a planned presidential election in Ukraine on May 25 is foiled, Chancellor
Angela Merkel and President Francois Hollande said on Saturday.

In a joint statement, they agreed to support tougher sanctions against Russia
- affecting areas such as energy, defense, financial services and engineering
- than European Union leaders outlined at a meeting in Brussels on March 6....

The May 25 election is to choose a successor to President Viktor Yanukovich
the pro-Russian president of Ukraine toppled by unrelenting protests. Russia
then seized and annexed Ukraine's Russian-majority Crimea region, citing threats
from what it called far-right extremists in the new Kiev government.

Knee - Military Escalation

Russia test fired an intercontinental ballistic missile today amid growing
tensions between Moscow and Washington, but a U.S. official said the launch
was planned in advance of the current crisis in Crimea....

A U.S. official confirmed the ICBM launch and said it was carried out through
protocols of the START Treaty.

Dutch fighter jets scrambled Wednesday to intercept a pair of Russian military
aircraft that entered their airspace, a fairly routine action that comes amid
heightened tensions between Russia and NATO, a Dutch official said.

Maj. Wilko Ter Horst said that the military learned around 3:50 p.m. (9:50
a.m. ET) that two Russian TU-95 bombers, known as Bears, had come a half-mile
inside its airspace.

Turmoil in eastern Ukraine continued Tuesday, a day after the United States
and Europe announced new sanctions against Russia for failing to take steps
to de-escalate the crisis in its neighbor to the west....NATO is boosting defense
in member nations bordering Russia to allay their growing concerns about Moscow's
territorial ambitions....

NATO already has increased its air policing and naval presence in the Baltics.
Last week, 450 U.S. paratroopers were deployed in Latvia, Lithuania and Estonia,
and another 150 in Poland. NATO military exercises are taking place across
the region.

On Wednesday, China announced that it plans to hold joint naval drills with
Russia in the East China Sea later this month.

"These drills are regular exercises held by China and Russia's navies, and
the purpose is to deepen practical cooperation between the two militaries,
to raise the ability to jointly deal with maritime security
threats," China's Defense Ministry said
in a statement published on its website...

"This shows unprecedented good relations between China and Russia," Professor
Wang Ning, director of the Center for Russian Studies at the Shanghai International
Studies University, told the New York Times about last year's drill. "It
shows that the two countries will support each other on the global stage.

Similarly, numerous signs suggest that after a decade of ongoing talks, Russia
and China are in the final stages of negotiating a massive 30-year natural
gas supply deal.

Once the deal is completed, according
to Bloomberg News, Russia's "Gazprom plans to supply as much as
38 billion cubic meters of gas to China, about 24 percent of the company's
deliveries to Europe last year."...

The two sides are hoping that the deal will be ready in time for Putin's
trip to China on May 20, which will take place immediately prior to the
joint naval drills.[Italics and underline my own]

The Associated Press reported Monday that Gen. Herbert Carlisle, Commander
of United States Air Forces in the Pacific, acknowledged a significant increase
in the activities by Russian long-range strategic aircraft flying along the
California coast.

There was no comment about whether the aircraft were nuclear capable, but
it has not been since the Cold War ended in the early 1990s that Russian patrols
have skirted the West Coast and California.

The US Strategic Command, the agency responsible for country's nuclear arsenal,
will hold large-scale war games this week that will include 10 B-52 Stratofortresses
and up to six B-2 Spirit bombers, along with other military and government
agencies.

The Boeing B-52 Stratofortress is a long-range, subsonic, jet-powered strategic
bomber built to carry nuclear weapons....

The exercise will be conducted from May 12-16 and is set "to deter and
detect strategic attacks against the US and its allies," the Strategic
Command said in a statement....

Though the timing of the exercise was declared as "unrelated to real-world
events," it does come on the heels of
the recent
war games in Russia. Announced in November 2013, military drills on countering
nuclear strikes were overseen by President Vladimir Putin ahead of the May
9 celebrations dedicated to victory in World War II...

Last week, NATO said it may permanently station additional troops in Eastern
Europe as a defensive measure against Moscow. Russia views this recent buildup
of NATO forces as a provocation and counterproductive in the struggle to deescalate
tensions in Ukraine.

Ear - Ukrainian Leadership: Pro Neo-Nazi or
Pro- Russian: Which Side?

Russia's foreign minister said Ukraine is sliding into a civil war that could
make it impossible to hold legitimate elections, as Ukrainian leaders and their
international allies blamed
Russia for the violence.

The Kiev government and its U.S. and European Union allies blame Russia for
the unrest in Ukraine's easternmost regions. Pro-Russian separatists there
were excluded from national unity talks that began yesterday in the capital
to ease tensions as a May 25 presidential vote looms. U.S. and EU leaders
say they'll tighten sanctions on Russia if the ballot is disrupted. Lavrov
said it's "ridiculous" to hold Russia responsible. [Italics mine]

If you want a good picture of how complicated the situation in Ukraine is,
look no further than Senator John McCain's recent trip to Kyiv....

You see, while the former presidential hopeful's weekend
trip was full of pro-Europe sound bites -- "Ukraine will make Europe
better and Europe will make Ukraine better," he told
a crowd in Kyiv's central Maidan square on Saturday -- and warnings of
stern reactions from the U.S. should Ukraine use violence against the protesters,
there's another detail to it that might cause McCain fans at home some concern.

However, the party's past is seriously murky. When it was founded in 1995,
the party called itself the Social-National Party of Ukraine (SNPU), and it had
a swastika-like logo. While it eventually split from its more right wing
members, the party remained focused on celebrating Ukrainian ethnic identity
in opposition to Russia and Communism.

Secretary of State John Kerry met with Ukrainian government officials and
opposition leaders Saturday, voicing the United States' support for the opposition's
goals even as protests raged in Kiev and across the country.

On the sidelines of the Munich Security Conference, Kerry told Ukrainian opposition
leaders Vitali Klychko, Arseniy Yatsenyuk, and Petro Poroschenko that they
have the backing of the United States.

The United States supports the "democratic, European aspirations" of Ukrainians,
Kerry said, according to a senior State Department official, and endorses the
opposition leaders' efforts "to defend democracy and choice for the people
of Ukraine."

The Western media has casually avoided to analyze the composition and ideological
underpinnings of the government coalition. The word "Neo-Nazi" is a taboo....

The Cabinet is not only integrated by the Svoboda and Right Sector (not to
mention former members of defunct fascist UNA-UNSO), the two main Neo-Nazi
entities have been entrusted with key positions which grant them de facto control
over the Armed Forces, Police, Justice and National Security.

Andriy Parubiy is the co-founder of the Neo-Nazi Social-National Party
of Ukraine (subsequently renamed Svoboda) was appointed Secretary of the
National Security and National Defense Committee (RNBOU)....

Parubiy was one of the main leaders behind the Orange Revolution in
2004. His organization was funded by the West. He is referred to by the Western
media as the "kommandant" of the EuroMaidan movement. Andriy Parubiy together
with party leader Oleh Tyahnybok is a follower of Ukrainian Nazi Stepan Bandera,
who collaborated in the mass murderer of Jews and Poles during World War II...

The World is at a dangerous crossroads: The structures and composition of
this proxy government installed by the West do not favor dialogue with the
Russian government and military. A scenario of military escalation leading
to confrontation of Russia and NATO is a distinct possibility.

The United States does not recognize "illegal" referendums in eastern Ukraine
on self-rule and views them as a transparent attempt to create further division
and disorder in the country, the White House said on Monday.

"We do not recognize the results," White House spokesman Jay Carney told reporters.

"We're disappointed that the Russian government did not use its influence
to forestall these referenda," Carney said.

The self-styled Donetsk People's Republic declared eastern Ukraine a "sovereign
state" Monday and called on Russia to annex the territory following controversial
referendums, RT.com reports.

The referendums Sunday in the Donetsk and Luhansk provinces have been denounced
by the U.S., European Union and Kiev government.

"We will try to cope with it on our own; we don't want this confrontation
to increase, especially on our territory," he said. "If the situation deteriorates,
we reserve the right to ask for a peacekeeping contingent."...

In Brussels, the European Union council on Monday refused to recognize the
referendums in eastern Ukraine and broadened its sanctions list against Russia
to include 13 more people and two businesses, officials said.

Britain and China have signed a deal to set up a yuan clearing service in
London, marrying future financial transactions between the Bank of England
and People's Bank of China....

"London is already recognized, along with New York, as one of the biggest
financial centres globally. It has made a lot of progress positioning itself
as a renminbi hub. Frankfurt and Paris are following suit," Reuters quoted
Spencer Lake, global head of capital financing at HSBC, as saying.

Chancellor George Osborne has been focusing on the world's second largest
economy and has been keen to open a yuan-trading hub in the capital city as
the currency poses stiff competition to the US dollar as a global medium of
exchange.

Germany's Bundesbank and the Peoples Bank of China agreed to cooperate in
the clearing and settling of payments in renminbi, paving the way for Frankfurt
to corner a share of the offshore market.

Germany's financial capital prevailed over Paris and Luxembourg in a euro-area
race to win trade in renminbi, which overtook the euro to become the second-most
used currency in global trade finance in October, according to the Society
for Worldwide Interbank Financial Telecommunication.

"Frankfurt is one of Europe's foremost financial centers and home to two central
banks, making it a particularly suitable location," said Joachim Nagel, a member
of the Bundesbank's executive board. "Renminbi clearing will strengthen the
close economic and financial ties between Germany and the People's Republic
of China."

China was Germany's third-biggest foreign trade partner last year, with 140
billion euros in turnover passing between the two countries, according to the
Federal Statistics Office in Wiesbaden. China ranks fifth among importers of
German goods and is the second-biggest exporter to Germany.

Russia's Gazprom and China are close to reaching a landmark gas deal and Moscow
hopes the agreement will be signed next month, Itar-Tass news agency quoted
Deputy Prime Minister Arkady Dvorkovich as saying on Wednesday.

"Regarding Gazprom's gas contract, the sides are close to agreement ... The
only issue remaining is ... the price," he said during a trip to China, adding
that Gazprom planned to discuss contract details with its partners on Wednesday.

As we have discussed numerous times, nothing
lasts forever - especially reserve currencies - no matter how much
one hopes that the status-quo remains so, in the end the exuberant previlege
is extorted just one too many times. Headline after headlines shows nations
declaring 'interest' or direct discussions in diversifying away from the
US dollar... and as
SCMP reports, Standard Chartered notes that at least 40 central
banks have invested in the Yuan and several more are preparing to do so.

Perhaps most ominously, for king dollar, is the former-IMF manager's warning
that "The Yuan may become a de facto reserve currency before it is fully
convertible." [bold is authors]

Voice
of Russia reports citing Russian press sources that the country's
Ministry of Finance is ready to greenlight a plan to radically increase the
role of the Russian ruble in export operations while reducing the share of
dollar-denominated transactions. Governmental sources believe that the
Russian banking sector is "ready to handle the increased number of ruble-denominated
transactions."

According to the Prime news agency, on April 24th the government organized
a special meeting dedicated to finding a solution for getting rid of the
US dollar in Russian export operations. Top level experts from the energy
sector, banks and governmental agencies were summoned and a number of measures
were proposed as a response for American sanctions against Russia...

None of what Russia is contemplating would have any practical chance of implementation
if it weren't for other nations who would engage in USD-free bilateral trade
relations. Such countries, however, do exist and it should come as a surprise
to nobody that the two which have already stepped up are none other than China
and Iran....

In other words, in one week's time look for not only the announcement of the
Russia-China "holy grail" gas agreement described previously
here, but its financial terms, which now appears virtually certain will
be settled exclusively in RUB and CNY. Not USD.

And as we have explained repeatedly in the past, the further the west antagonizes
Russia, and the more economic sanctions it lobs at it, the more Russia will
be forced away from a USD-denominated trading system and into one which faces
China and India. Which is why next week's announcement, as groundbreaking as
it most certainly will be, is just the beginning. [referring to Putin's
visits Beijing on May 20th surrounding the annual joint naval exercises between
Russia and China in the South China Sea, and speculating that oil and gas contracts
could be signed between the two nations, and the contracts will be denominated
in rubles and yuan, not US dollars.]

Summary of "The Elephant"

I know that this brief look across various media sources from the last 3 months
is overwhelming. It should be, especially in light of financial markets that
continue to yawn at all of this information, as though systemic risk at the
geopolitical, global banking, and economic levels have nothing to do with our
lives. In the words of Chairman Bernanke in September 2012, "if people feel
that their financial situation is better because their 401(k) looks better
or for whatever reason -- their house is worth more -- they're more willing
to go out and spend."

And when a society is driven by feelings and the desire to keep up an illusion,
even if for years we are told that it will take unlimited debt and market intervention,
it is always easier to believe that the longer manipulation goes on, the longer
it can go on.

We can read and see signs of the dam cracking in front of us, and yet take
no action. Why should we? We have been told "this time" the dam will not break,
and our recent experience has only reinforced this belief....until it doesn't.

"As early as three hundred years ago, the mathematician Pascal wrote, "ordinary
people have the ability not to think about things they do not want to think
about." [The Journal of Behavioral Finance, Vol 6, Number 1, 2005, pg 28]

Preparation Time is Running Out

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Noteworthy service. Twice a month, I take world news headlines and tie
them to a piece of history in our financial markets. Connecting dots has
never been more crucial.

May 2004 I released my first public newsletter, seeking to share what I was
learning from others. In the months ahead, this decade of learning, writing,
and living through many "first in history" events will be seasoned in ongoing
writings as we move from illusion to reality yet again, something we have already
seen twice since 2000.

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